The crab-like performance of the last two years is not easy to explain – a third year of the same would be distinctly weird
On the Saturday before Christmas the shop windows told their own story. Up to 50% off at Hobbs. Discounts of 60% at LK Bennett. Similar reductions at French Connection and the Gap. The sales started early this year and that means the economy is struggling. Fearful of being left with large amounts of unsold stock, retailers are slashing prices to attract hard-up consumers.
It was the same a year ago. Hopes of recovery have been dashed in 2012, a year in which the UK has gone nowhere fast. Interest rates, gross domestic product and house prices are where they were in January. The economy is not collapsing but it is not growing either. For the past two years it has gone sideways, and the expectation at the Bank of England and the Treasury is that 2013 will be little better.
Historically, it is extremely unusual for the economy to be stuck in a groove like the needle on a vinyl record. Subsistence economies can have long periods of low or zero growth but modern western economies traditionally do not. There is a cyclical pattern in which periods of slow growth gain momentum, ending in a boom-bust phase. A recession, normally relatively brief, removes the excess and allows the cycle to begin again. For the past century, this process has been lubricated by government action: interest rates are raised to stifle mounting inflationary pressure in the boom then cut in order to get growth and employment rising again during the downturn. Tax and spending policy has tended to operate in the same counter-cyclical fashion.
The crisis of the past five years can be divided into two distinct phases. What happened in the first phase was entirely predictable: the financial collapse of 2008 and the economic slump of 2009 followed inexorably from the asset price bubbles of the mid-2000s. It was a big collapse because there was a big bubble.
Less easy to explain is the crab-like performance subsequently. The UK economy has not really budged since the autumn of 2010, something that has not happened since the second world war and probably for a long time before that. Other western economies have broadly followed the same pattern. The US has grown a bit faster than the UK and the eurozone is already in a mild double-dip recession, but there has been the same sense of economic torpor. A third year of the same would be distinctly weird.
Could it happen? Yes, of course it could. In some ways, not a lot has changed since before the crisis. Real income growth is still weak, but is no longer being supplemented by large dollops of borrowing. Banks are still recognisably the same creatures they were in 2007 but are sitting on vast quantities of underperforming assets. Macro-economic policy has been aggressive enough and persistent enough to prevent a fresh slump of the sort seen four years ago but no more than that.
Expectations are already so low there is a chance that 2013 will surprise on the upside. The passage of time together with policy action could finally work over the coming months, particularly if the Americans come to a budget deal and the eurozone gets to grips with its debt crisis. There is plenty of spare capacity in the global economy and that, in normal circumstances, would point to several years of above-trend growth.
Recent US data has looked relatively perky. Rising housing starts indicate that the long real-estate recession is over. Investment is picking up and jobs are being created. Barack Obama’s second term will be easier than his first.
Similarly, the worst for the eurozone may now be over. To be sure, the economic numbers are still dire and austerity is still hurting, but the financial markets were impressed by Mario Draghi’s insistence that the European Central Bank would do whatever it took to safeguard the future of the single currency. The next 12 months are not going to be easy, but historians could well look back to Draghi’s speech in London in July 2012 as the moment the corner was turned.
What then do we look out for in 2013? For the UK, the short-term threats are a triple-dip recession and a credit downgrade. The rating agencies have the UK in their sights and it won’t take much more bad news for the AAA status to be removed.
George Osborne will not have an easy year and in the budget will face the dilemma of whether to tighten policy further in the face of fresh fiscal slippage despite weak growth. Some analysts, such as Vicky Redwood at Capital Economics, believe the UK has more spare capacity than the Office for Budget Responsibility is estimating and that the size of the structural deficit is therefore not as big as feared. That means that the plans for budgetary tightening are too tough and could be relaxed. This would be sensible but it is unlikely to happen.
So where is growth going to come from in 2013? Not from the government, which has pledged no let-up in the austerity programme. Not from the consumer, who is seeing rising prices reduce the value of near-worthless pay rises. Perhaps from exports if the skies clear over the eurozone and the US does not hurtle over the fiscal cliff; perhaps from investment if brightening export prospects persuade companies to spend some of the cash balances they have accumulated in recent years.
Don’t bank on it, though. On past form, Europe will find a way of snatching defeat from the jaws of victory and the UK will continue to remain highly risk-averse. The Bank of England’s Funding for Lending Scheme may help to increase the flow of credit and reduce its cost but Threadneedle Street is fighting two powerful headwinds.
The first is the inability of first-time buyers to get a foot on the housing ladder due to the combination of high prices and the big deposits demanded by lenders. The second is that real incomes continue to be squeezed. Capital’s victory over labour since the late 1970s has come at a price: workers lack the purchasing power to buy the goods and services they are producing, and they are no longer willing or able to borrow the money to do so. Hence the high street early bargains. There will be more, it is fair to assume, in 2013.